When people decide where to live there are many factors which are taken into account, and the subjective ranking of these end up determining whether we settle in one place or another: proximity to family, climate, views, love of country side or the big city; the list is endless. The price of property may be a key determinant: the same money which buys you a small flat in Manhattan may afford you a mansion in a remote corner of Texas. On the other hand, rural Texas does not offer the job prospects of New York, nor does it have the cultural life or any of the many other aspects of big city life which attracts so many people and in turn drive up the cost of housing. Another thing, however, also sets the two locations apart: the Texan town is in “tornado alley”, where from time to time a tornado rips through the landscape, tearing everything apart which stands in its way. Fortunately for the Texas resident, when disaster strikes federal help is on the way in the form of disaster relief: government will help getting those who suffer from natural disasters back on their feet. And surely, that is a good thing? Even the most cold-hearted libertarian can’t deny that here is a role for government, because leaving people whose lives have been torn asunder to their own devices can’t possibly be right… Or can it? Do libertarians have a case against government intervention even when it comes to disaster relief?
To examine the question, let’s imagine a small town built next to a river. There are a few houses built along the flowing waters, but most of the community’s residents live further up the bank of the river in the town centre. Riverside property is scarce due to physical constraints, but it is popular because of its beautiful views and the many other advantages of occupying the shore of the river. There is really only one downside to these prime properties: the risk of flooding is much higher than for an otherwise comparable property in a more elevated position. And now, what they feared has happened: torrential rain has made the river rage and those beautiful houses along on the edge of the river all lie flooded in several meters of muddy water.
Of course, until the flood hit, the riverside residents didn’t share the perks of their properties with neighbours further up in town. Those whose houses are located up the riverbank, away from the flowing waters, didn’t get the views, they couldn’t enjoy morning coffees in the boat house, lazy afternoons fishing from the garden or any of the other benefits which made riverside houses so attractive. In other words, they did not participate in the benefits of the houses by the riverside; those were exclusive to the occupants. But now, when the risk associated with the exposed position have materialised, they are promptly asked to share the cost: the government has collected taxes from everyone and kept them saved up for just this occasion (remember: this is a fictional tale). Government rides to the rescue, sending helicopters to save resident stranded on the roofs of their houses, putting them up in temporary accommodation while they assist in cleaning up, and promising that no-one will be left alone to deal with the aftermath of the flood. Residents of the town centre watch, but mixed with the sense of relief that no lives were lost in the disaster is a creeping feeling that they are being taken advantage of. Because disaster relief is a classic example of private benefits and socialised costs. Town centre residents have, indeed, been ripped off; they have been coerced into providing compensation for economic cost associated with risk which was inherent in other people’s properties.
The result of this arrangement is too many riverside properties: if residents were asked to own the risk of flood, the cost of riverside living would increase – if flooding was a frequent occurrence, it might be that no properties at all would be built close to the river’s edge, because no resident found the benefits of direct river access valuable enough to compensate for the fact that they’d have to bear the cost of repairing flood damage every few years. But the government has made correct economic calculation impossible, hiding from riverside residents the true cost of their decision to build close to the water’s edge.
It would be easy to rectify. The private insurance market is able to quantify myriads of risks and put a price on assuming it. It already provides billions of disaster insurance to both individuals and companies. But a large part of the economic risk of natural disasters is left unaddressed for no other reason than that we all know that the government is assuming it: the state provides the coast guards who form rescue teams, open public building for accommodation, repair infrastructure etc.
Only when we bear the full benefit AND cost of our decisions do we make them optimally. Disaster relief may encourage people to live where no-one should live at all, because the real cost of doing so massively outweighs the benefits. But those who choose to live their lives along river banks prone to flooding, in the path of hurricanes and tornados or in earth quake zones, are not faced with the true cost of the choice they are making. Instead, they saddle people who do not enjoy the benefits with part of the bill for cleaning up when disaster strikes. The government, in its effort to do good, has created a moral hazard. The libertarians were right after all.